Why Westpac Banking Corp’s (ASX:WBC) share price spent the morning in the red

Credit: perry carbonell

Shares in Westpac Banking Corp (ASX: WBC) were trading deep in the red this morning in contrast to the other big banks following its profit warning and a broker downgrade.

The stock tumbled 0.9% to $27.27 at the time of writing when shares in Commonwealth Bank of Australia (ASX: CBA), Australia and New Zealand Banking Group (ASX: ANZ) and National Australia Bank Ltd. (ASX: NAB) are trading in the black.

Westpac announced yesterday evening that it will take a $235 million hit to cash earnings as it has to set aside the cash for customer remediation (relating to fee for no service), litigation costs and other related expenses.

Some might feel the share price drop is an overreaction given that the provision is a small amount for a bank that’s expected to post an FY18 cash profit of around $8 billion, but this is only the tip of the iceberg.

Even Westpac admitted that the provision doesn’t include the millions it spent fronting the Banking Royal Commission and I am fully expecting further lawsuits to be filed against Westpac in the near-term after NAB got slapped with a consumer class action yesterday.

The uncertainty about what other provisions Westpac will have to make has prompted Bell Potter to downgrade the stock to “hold” from “buy” even though it only modestly cut its price target on the stock by around 3% to $29.75 a share.

“there is also further downside risk to cash earnings as WBC continues to investigate and consider further costs in the matter of other advice fees,” said the broker.

“Because potential costs associated with responding to the Royal Commission and work in respect of other advice fees are not included in the charge, we feel a Hold rating is more prudent at this time.”

What’s more, the Banking Royal Commission is handing down its interim report today which may include recommendations on harsh new restrictions that could curb bank growth and increase compliance costs.

On the flipside, bank supporters point out that if the recommendations in the interim report doesn’t add materially to cost or restrict growth (as some experts believe will be the case), the share prices of the big banks could pop higher.

The sector has severely underperformed the S&P/ASX 200 (Index:^AXJO) (ASX: XJO) index as a lot of bad news is priced into their share prices, including that of AMP Limited (ASX: AMP).

It won’t take much to trigger a relief rally although I will certainly be waiting to hear what the Hayne Royal Commission says before deciding to jump in.

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Motley Fool contributor Brendon Lau owns shares of Australia & New Zealand Banking Group Limited, National Australia Bank Limited, and Westpac Banking. The Motley Fool Australia owns shares of National Australia Bank Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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